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Strategies & Market Trends : The Art of Investing -- Ignore unavailable to you. Want to Upgrade?

To: Sun Tzu who wrote (139)	10/1/1998 2:16:00 AM
From: Sun Tzu	Read Replies (2) \| Respond to of 10675

Ok here is my dooms day scenario. If you think it is on the right track and most importantly, let's discuss the trading strategies that will make us money if it pans out (i.e whom to short, what to hedge, who is most exposed in each phase, ...). First a bit of background on the Japanese banks as I understand them. Japanese banking laws allow the banks to treat their collateral as reserve and pyramid on top of that. This means that if a bank has only 10B in reserves, it can lend out 50B in loans while accepting say half of those loans as collateral (in this case 25B) now let's say those loans were put into stock market and the market doubled. This would double the value of the bank's collateral from 25B to 50B. Under Japanese law, this excess 25B can be treated as "reserve" thereby allowing the bank to lend out another 125B on the back of this "reserve". So now the bank has lent out 175B on the back of the original 10B reserve and if the new loans perform well (which they did for a long long time) then the bank can pyramid on top of them again indefinitely. And indefinitely pyramiding they did. Most of these loans went into real estate (where at its peak valuation the Emperor's palace was worth more than the entire state of California, and I can't guess how much it has fallen) and the stock market (40,000 at its peak and now a 12 year low ~13,000). Now the problem for the banks is that they have too much unsecured loans and are not able to pay back their depositors. Also, legally they should not be able to operate. So what have they been doing to stay afloat? Enter financial magic. Rather than cutting their losses like a good speculator (that is what they were when they used the collateral as reserves) should, the banks waited "hoping" for a bounce that never came (actually it did, but then they got greedy again). So what they've done is two fold: number one they have been carrying the assets (read bad loans) at book value rather than current value to give the illusion that they are solvant. Number two, they've bought the politicians in the government to actively buy the stocks and put a floor under the stock market (since it would be impossible to claim a "book" price for shares that are clearly trading at much lower levels). This government manipulation of the stock market is why Nikkei never goes below 13000 (at least so far). Actually the real line was drawn at 15000, but they've been able to massage the numbers so far. In addition, government encouraged the healthy banks to buy the sick one to prevent their death, but this made the healthy banks sick as well. Implicit to this government-bank relationship was that the government would never allow any major bank or their affiliates to go bust. The problem is that this arrangement is changing. This approach has not worked so far and the opposition is forcing the government to change. The first sign of the change was the collapse of the Leasing bank an affiliate of Japan's Long Term Credit bank which itself is facing insolvancy (I'm going avoid everything with "Long Term" in its name ;). And it seems that the government may not be willing to buy out the stocks to support the banks either. Here is some excerpts that do a good job of explaining the change. I'm including the links. search.washingtonpost.com "I hear from banking sources that banks are calling in loans," said Masaaki Higashida, a strategist with Nomura Securities. "I think it's only natural. Those who did not secure their loans [to Japan Leasing] with collateral will try not to make the same mistake again. And those who were able to secure their loans with collateral will want to continue to do that." "Up until now, most creditors have behaved in a gentlemanly manner. But I am told it is now no longer gentlemanly," Higashida added. . . . Until Sunday night, many creditors assumed that loans were relatively safe if they were made to borrowers with close relationships to a major bank. Japan Leasing is an affiliate of Long-Term Credit Bank of Japan, one of Japan's 19 largest banks, which has propped up the financially ailing leasing company for years. (It is not related to the similarly named Long-Term Capital Management, the Greenwich, Conn., investment fund that nearly failed this week.) dailynews.yahoo.com The market opened higher on hopes that the government, via public fund buying, would push share prices higher to help the balance sheets of companies as they close their books for the fiscal half on today. But when the public fund buying didn't materialize, prices dropped sharply in the last 30 minutes of trading. also read yomiuri.co.jp All this means that if the banking system in Japan collapses, in addition to the standard category 3 hurricanes that it will unleash on the stock markets around the world, our remaining safe haven, the U.S. T-bills, may prove to be quite unsafe as the may get repatriated back to Japan. Which will bring about a whole set of other problems. The obvious thing to do in such a case is to short every money center bank and major brokerage firm. I am all ears as to suggestions for what else to short or long and what pair trades will provide the best hedge returns. Semiconductor capital equipment makers will be another weak spot. Russell 2000 however has been doing better on down days than the rest of the market. So buying RUT future and selling Dow futures may be another good trade, though I don't like it much since on the up days Russell underperforms. So any suggestions on this is welocomed. When will it end and how will we be saved? I'm glad you asked. There is talk around the Globe of a new "Bretton Woods" or "Marshal" plan. This would definitely work and when it happens, properly positioned you will make millions. The problem is that I don't think that we have the kind of leaders who can pull this off before things get really bad and set the public opinion for it. Here is by the way why I think that such a plan is in the works: (1) Japan is planning to set aside $30 B. to ease the credit crunch in SEA. (2) British Prime Minister Tony Blair said recently that we must "commit to build a new Bretton Woods for the next millennium." (3) Greenspan said (in his recent comments to the Congress): I do think that we have to bring the existing instabilities to a level of stability reasonably shortly to prevent the contagion from really spilling over and creating some very significant further difficulties for all of us. I can't comment to you on that at this particular stage what particular actions will or will not be taken. But I really would suggest to you that I think we know where we have to go. I do not think we underestimate the severity of the problems with which we are dealing. But exactly what instruments we will employ and, well, when they will be employed, I'm not at liberty at this stage to offer because I'm not the only person involved in making the decisions. (4) President Clinton, in his address to the Council on Foreign Relations, spoke of the present crisis as the "biggest financial challenge facing the world in half a century." He said in part: For half a century now in our national economy we have learned not to eliminate but to tame and limit the swings of boom and bust. In the 21st century we have to find a way to do that in the global economy as well. We have been working on this for three years at some level of intensity or another going back to the G-7 meeting in the aftermath of the Mexican financial crisis. In this room I think it is not too simple to say we know what to do. The World War II generation did it for us 50 years ago. Now it is time for us to rise to our responsibility...We must work to lift the weight of private sector debt that has frozen the Asian economies. Today I'm asking Secretary Rubin to work with other financial authorities ... to explore comprehensive plans to help Asian corporations emerge from massive debt where individual firms have been swept under by systemic national economic problems rather than their own errors. So tell me what you think. Let's dust off the crystal balls. Sun Tzu